How to Assess Providers for Lifetime Income

Plan sponsors do not have to
provide in-plan lifetime income solutions for their plan participants. However,
the topic is heating up as the issue of how participants will manage account
balances to provide sustainable lifelong income garners more attention.

Fiduciaries responsible for selecting annuity providers are not obligated to
follow the steps in the safe harbor regulation, the paper notes. But they
should consider four main areas—the company’s financial strength; the
provider’s evaluation by the rating agencies; commitment and success in the
insurance industry; and diversification of business lines—as part of a prudent
process.

Of these areas, financial information
about a provider is the most important, says Ashton, a partner in Drinker Biddle
& Reath’s Los Angeles office, and the section that is most likely to
require the assistance of an outside professional, he says.

“In my experience, not too many
committee members are going to be very knowledgeable about insurance
companies,” Ashton tells PLANSPONSOR. The largest firms are unlikely to have the
expertise in-house to really determine the strength of an insurer.

Ashton suggests seeking the
assistance of an adviser or consultant with specialized knowledge who is
steeped in the industry. “There are some who understand the insurance industry
and the strengths of various insurance companies,” he says.

In short, Ashton says, the plan
sponsor wants to determine how long the provider has been in business; the size
of the business in serving this market specifically, and what their reputation
is.

“The short answer is no,” Ashton
says. However, he notes that recent
guidance from the Internal Revenue Service (IRS) and the Treasury
Department—IRS Notice 2014-66 and an accompanying letter from Phyllis Borzi,
assistant secretary of the DOL—should give people some comfort that regulators
are trying to allay concerns about these types of products.

“The Borzi letter makes it clear
that it is certainly permissible that you could engage a 3(38) investment
manager to make the determination,” Ashton says.

The plan sponsor and plan
committee, Ashton says, can see if the consultant or adviser will take on the
role of a 3(38) investment manager, and have them make the decision about
choosing a provider. “That’s what the structure was in the 2014-66 notice,” he
says. “The letter from Borzi pointed out that if you have an investment
manager, they’re making the responsible decision, and that’s OK.”

The aspects of an insurance
company’s finances are quite detailed, ranging from analysis of the firm’s
asset valuation reserve, to diversification of assets, to liquidity, to Fortune
500 ranking. Drinker Biddle’s paper has a sample checklist in the appendix for
use in evaluating an insurance company, and specifics on how to access information:
Some can be obtained by asking the insurer; some from independent sources, such
as ratings agencies or the National
Organization of Life and Health Insurance Guaranty Associations.

The following are characteristics
that can be used to assess financial strength:

Bond quality: The National Association of Insurance Commissioners
bond quality can be found on the insurer’s website or can be requested from the
insurer. Investment-grade bonds should be at least 90% of the bond holdings of
the General Account.

Diversification of invested assets: bond type and duration;
preferred stocks; common stocks; real estate; alternative investments.
Questions to ask include: Are the bonds owned diversified among bond types? Are
the bond maturities diversified according to the following time frames?

Insurer’s asset liquidity: This can be found on the annual
statutory statements. Total bonds, total cash and total mortgages can be found
on the assets schedule; while the total reserves can be found on the reserve
analysis.

Fortune 500 Ranking: Life and Health insurance companies are listed
either as a stock or a mutual insurance company.

Analysis of insurer’s statutory capital: Data on the capital,
surplus and asset valuation reserve of an insurer can be found in the annual
statutory statements (Blue Book) and from the individual rating agencies
(Fitch, Moody’s, Standard & Poor’s, and A.M. Best).

Plan sponsors should factor in the
quality of the company’s ratings by Fitch, Moody’s, Standard & Poor’s, and
A.M. Best. Ratings from each company should be examined to determine the
consistency or lack of consistency among the rating agencies. Ratings over a
five-year period (or longer) can help determine if the trends have been stable
over time or have fluctuated in economic cycles. Read the report that
accompanies each rating agency’s rating to see if there are adverse comments
that suggest vulnerability to future economic events.

Check insurance company annual
reports and insurance company websites as well as the individual rating
agencies.

Acceptable ratings for financially
strong companies are considered to be A- or higher by either A.M. Best, Fitch
and Standard & Poor’s, and A3 or higher from Moody’s.

Determine the company’s commitment and
success. How long has the company been in business? The annuity provider should
have enough history to demonstrate the ability to maintain a strong balance
sheet through different market cycles. Drinker Biddle recommends that an
insurance company have a minimum of 10 years in the annuity industry and
annuities with living benefits.

How large is the annuity business?
This can be determined by the number of annuity contracts and the amount of
annuity assets. A well-established annuity provider would have a minimum of
250,000 contracts, and total traditional annuity assets of at least $15 billion,
with at least $5 billion with living benefits.

Annuities and income guarantees should
be one of the core business lines (at least 10% of annual revenue) of the
insurer.

Review the insurance company’s
Form 10-K for the company’s regulatory history and litigation history, with
particular focus on potential impacts to the annuity business.

Determine the business lines—for
example, annuities; life insurance; group insurance; retirement plans; other—from
the insurance company’s Form 10-K or annual report. While diversification by
itself does not insure that an organization is financially sound, it can help
with volatility when compared to a single line of business. Any insurance
company that has a single or limited line of business should be closely
scrutinized.

Is the company broadly diversified
across different lines of business?

What is the revenue (in millions)
by business line or division for annuities; life insurance; group insurance;
retirement plans; other?